A married couple is reviewing their financial plan for retirement.
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The decision to retire can be a bit nerve-wracking. Retirees potentially have a lot to worry about – some of which are out of their control – such as how the market will perform and how quickly supermarket prices will rise.
But regardless of the economic climate, simple mistakes can prove costly for retirees.
Here are some common mistakes you’ll want to avoid as you enter your golden years. And if you need extra help planning for retirement, consider reaching out to a financial advisor.
Did you know that you may have to pay income taxes on your Social Security benefits? Depending on your other sources of income, up to 85% of your benefits may be taxable. The income thresholds that trigger taxes are set at specific amounts and do not adjust for inflation, meaning more retirees exceed these tax limits each year.
Estimating your potential tax burden is complicated (you can find an example here), but it starts by taking half of your Social Security benefits and adding them to your adjusted gross income (AGI) and any tax-free interest you may have earned. If the resulting total is $25,000 or more ($32,000 for joint filers), you will pay taxes on up to 50% of your Social Security benefits. And if that total is $34,000 or more ($44,000 for joint filers), up to 85% of your benefits will be taxable.
You can use this Social Security Administration calculator to estimate your tax liability or work with a financial advisor to see how your Social Security tax bill could affect the rest of your financial plan.
If you have an individual retirement account (IRA), 401(k), or a similar tax-deferred retirement savings account, your withdrawals are taxed as ordinary income (and may trigger the Social Security taxes mentioned above). You should consider these taxes or look for ways to reduce them during your retirement.
One strategy is to take some or all of your tax-deferred savings and roll them over into a Roth IRA. You pay tax on the money you convert now, but all future profits are tax-free. You can convert just enough of your IRA balance each year so that you stay in your current tax bracket and don’t move into a higher bracket.
Required minimum distributions (RMDs) are an important part of retirement planning because they can increase retirees’ tax liability.
Speaking of IRAs and 401(k)s, once you turn 73 (or 75 for those born after 1959), the IRS forces you to start taking required minimum distributions—the dreaded RMDs—from your tax-deferred accounts. The amount is based on your account balance at the end of the previous year and your expected life expectancy. You’ll want to get this right because if you don’t, you’ll owe a 25% penalty on the amount you should have withdrawn (it used to be 50%).
Strategies to minimize taxes on RMDs include delaying Social Security payments and taking larger withdrawals early in retirement to reduce your taxable account balances. Meanwhile, Roth assets are not subject to RMDs, so doing a Roth conversion can eliminate your RMDs. Finally, if you don’t need the money to cover living expenses, making qualified charitable distributions (QCDs) from IRAs can meet your RMD requirement while not adding taxable income to your bottom line.
While SmartAsset’s RMD calculator can help you estimate how much your first RMD will be, a financial advisor can help you plan for the tax consequences of these mandatory withdrawals and take steps to reduce or eliminate them.
Your pension plan must take inflation into account. On average, the cost of living increases by 2% to 3% every year. Over the course of a twenty or thirty year retirement, that higher cost of living will steadily erode your hard-earned savings. Remember that after twelve years, inflation would increase the cost from $10 to $15.
Accounting for inflation is one reason financial planners advise retirees to invest a significant portion of their retirement savings in stocks; the interest on bonds and savings accounts often does not keep pace with inflation. If you don’t take inflation into account, your savings could lose their purchasing power and not last as long. If you need help creating a retirement income plan that keeps pace with inflation, consider contacting a financial advisor.
Most people working today don’t reach full retirement age until they turn 67 — but they should apply for basic Medicare in the three months before or after age 65. If they don’t, they face penalties ranging from 1% to 10% for every 12 months they delay registration. Medicare has several separate elements ranging from Parts A, B, C, and D to plan add-ons that go all the way up to Part N. Filing for Medicare isn’t as difficult as it seems, but you still need to do your homework on what’s involved. and what papers you need.
You may be tasked with managing several accounts in retirement, including 401(k)s, IRAs, and Roth accounts.
Once you retire, you’ll want to get a handle on all your retirement savings, including IRAs, taxable investment accounts, savings accounts, pensions, and 401(k) accounts or similar workplace plans. If you have multiple 401(K)s at previous jobs, your best bet is to roll them all into one consolidated IRA. However, if you’re still working, you may want to roll over old 401(k)s into your current employer’s plan, which will allow you to defer RMDs.
You may consider combining several IRAs into one easier-to-manage account or converting some or all of the money into a Roth IRA. You also need to plan how you will structure your “retirement salary”: the income you want to receive from all your retirement accounts, plus any pensions and Social Security benefits. Keep in mind that a financial advisor can help you transfer accounts and manage your savings once they have been consolidated.
Retirement planning can be intimidating, especially when you consider the costly mistakes that lie ahead. However, the first step is to draw up a pension budget. Then, review your assets, take inflation and healthcare costs into account, and create an after-work investment strategy. It seems like a lot, but if you take it step by step and start at least a year before retirement, it can all be manageable.
Fidelity recommends that you save ten times your annual income for retirement before age 67. To find out if you’re on the right track, try SmartAsset’s retirement calculator. This free tool estimates how much you will have left when it’s time to retire.
The transition from work to retirement can seem difficult, and speaking to a good financial advisor can make it easier. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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